In this newsletter we look at the Quarter 2 2023 earnings season
What is Earnings Season:
Earnings season happens each quarter (December, March, June, and September), whereby the majority of large, listed companies announce their quarterly earnings (usually a few weeks after each quarter). Important to note that whilst it is called earnings season, there are several different factors announced in a company’s financials that play a role, none more so crucial than comments made by the executives of the companies. These announcements bring about high levels of activity in the market as analysts and traders compare their expectations to the actual results and try to read between the lines of what the comments of the executives mean for the future outlook of the company. Thus, it is not uncommon for a company’s share price to move 20% and change from a buy to sell (or visa-versa) in the space of a few days.
Macroeconomics
Of course, macroeconomics plays a substantial role in both expectations and the actual company results and affects each sector differently. For example, in Q2 2022, 75.8% of S&P 500 index constituents surpassed EPS expectations. Despite this, the S&P500 was down 16.1% for Q2 2022. This was due to macroeconomic issues that affected stock markets in 2022, namely increased inflation expectations, the Fed tightening monetary policy, the Russia/Ukrainian war, and covid induced shutdowns in China. Whilst the macroeconomic debate on inflation versus interest rates has dominated the discussion over the past 18-24 months, the end of the 2nd quarter of 2023 brings about the 2nd earnings season for the year. It provides us an opportunity to take a welcome break to have a discussion regarding some of the more particular reasons as to why companies are performing or not, rather than all being lumped into the category of Global equities in a macro debate.
If we take a broader look at how the S&P500 is doing by sector in this earnings season, overall, 51% of the companies in the S&P 500 have reported actual results for Q2 2023 to 28 July 2023. Of these companies, 80% have reported actual EPS above estimates, which is higher than both the 5-year average and the 10-year average for the S&P500. Six of the eleven sectors (consumer discretionary, communication services, industrials, real estate, financials, and consumer staples) report year-over-year earnings growth, led by the Consumer Discretionary (36.1%) and Communication Services (20.2%) sectors. On the other hand, five sectors (information technology, utilities, healthcare, materials, and energy) are reporting a year-over-year decline in earnings, led by the Energy (-52%) and Materials (-31.8%) sectors.
But while earnings have remained resilient, only 64% of companies have announced revenues that have beaten their estimates, which is worse than the 5-year and 10-year averages. Even though companies were beating expectations this time last year in the tumultuous 2022 climate, the noise around the macro-debate still reared its ugly head, driving markets downward; now that noise is dying down and the spotlight is shining a little brighter on individual company performance again, it will be interesting to see the winners and losers this earnings season.
Highlighted in the table below is just how well each sector has done against the expectations set by analysts.
Talking Points
Some of the main talking points in this earnings season are Tesla and Johnson & Johnson. Tesla’s share price dropped just shy of 10% (9,74%) in the hours/day following their Q2 2023 earnings announcement. This drop came despite beating their estimated earnings per share by more than 11% in the same period and having a 47% increase in revenue versus the same point in 2022. So why did this happen? For starters, their polarizing CEO, Elon Musk stated that even though price cuts meant that their gross and operating margins were already down for Q2, there are likely to be further price cuts over the next year. In addition to this, it was announced that vehicle production is expected to slow for Q3 due to factory improvements.
Johnson & Johnson share price had dropped more than 5% year to date. Still, after announcing their Q2 earnings, beating their estimated earnings per share and estimated revenue, their share price closed 6% higher in one day as a result of the positive earnings news. This highlights just how volatile stocks can be during these quarterly earnings updates. Other examples of positive earnings and comments from CEO’s positively affecting stock prices this earnings season are Meta and Alphabet, who both announced their earnings in the final week of July 2023. Their share price rose approximately 8% and 6%, respectively, in the hours/day following their announcements.
Paragon House View
We have had a bullish view on equities since Q3 last year but are starting to become less optimistic and are taking a risk-off view into the back half of this year. This does not mean that we are cutting our equity positions altogether but instead trimming our exposure as a tactical pivot and not adding to equities as aggressively. We believe equity risk has increased and expect weakness in the stock market to be corrective in nature rather than a new bear market. EPS for the S&P 500 is troughing, and Fed tightening is late. The recent US sovereign credit downgrade from AAA to AA+ by Fitch Ratings on 1st August 2023 is also something to keep a close eye on as it indicates that it may lead to higher borrowing costs for the US government and cost US taxpayers more. This is only the second time in US history that its credit rating has been cut. Fitch cited the worsening political divisions around spending and tax policy as a critical reason for its decision. Another factor in Fitch’s decision is that it expects the U.S. economy to tumble into a “mild recession” in the final three months of this year and early next year (Rugaber, 2023).
Our long-term view remains favorable for equities, and we continue to allocate on the traditional 60/40 (equity/bonds and alternatives) split for our balanced investors with a 5-year time horizon. Further, we expect that the FED will leave interest rates unchanged between now and next year, February, at which point we expect them to start cutting. This expected pivot should be beneficial for the equity markets as lower discount rates and higher future cash flow valuations will typically show in share prices.
